How Do You Know If A Country Is In Recession?

In the ongoing discussions of economic news and information in the media, we often come across talk of recession and recovery in reference to the performance of the economy. What is a recession? And how do we know when one occurs?

The Business Cycle: Expansion And Contraction

The economy, while encompassing a large group of indicators like growth, employment, inflation and interest rates, is understood as a whole to be a dynamic phenomenon that grows and shrinks, or "recedes." This process has been defined by economists as "the business cycle" and recession is a phase of the business cycle when the economy is on a shrinking trajectory.

A Scarcity Of Money?

The notion of recession in the business cycle has been recognised in one form or another since the formal development of modern economic theory in the late 18th century by Adam Smith. He referred to the "scarcity of money" caused by "over-trading."[1] Early economists in continental Europe referred to an economic downturn as a "commercial crisis," and in England, a sudden reduction of market confidence and economic activity came to be known as a "panic."[2]

Although uncommon, panics can have profound impacts on consumer confidence, fiscal policy and the financial markets. Whether one is talking about the 1929 U.S. stock market crash or the Great Recession of 2008, it's important to understand the potential destruction caused by panic.

Explaining The Big Crash

The formal notion of a recession began to take form in the 1930s following the outset of the Great Depression, as economists struggled to determine how economic activity in the U.S. and around the world had suddenly come to a halt following a period of exuberant economic activity in the 1920s. While the term depression had been used as early as 1820 by President James Monroe to refer to the "Panic of 1819,"[3] the term recession appeared in popular usage following the market crash of 1929 in an article in The Economist.[4]

The term gained more refined definition over the following decade from renowned economists like John Maynard Keynes, who referred to "recession and recovery" in his book The General Theory of Employment, Interest and Money. There was also Joseph Schumpeter, who in his work Theory of Economic Development and Business Cycles stated the business cycle undergoes four phases: Expansion, Crisis, Recession and Recovery.[5]

The National Bureau Of Economic Research (NBER)

Since 1978, recessions in the U.S. have been formally defined by the National Bureau for Economic Research (NBER), a private, non-profit organisation that has a business cycle dating committee dedicated to the subject.[6] In Europe, a similar agency, the Centre for Economic Policy Research, carries out that task.[7]

Over the decades, NBER has become a world-renowned authority on business, commerce and consumer behaviour. The bureau regularly releases formal studies in these areas via working papers, books and lectures. Primary segments of research pertain to macroeconomic issues such as the unemployment rate, GDP growth and real GDP.

NBER Definition Of A Recession

The NBER defines a recession as follows:

"A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion."[8]

On an ongoing basis, NBER diligently scrutinises such events and is viewed by many as an authority on both the U.S. economy and global economy.

Of course, one of the key components of a recession is the period of time between peak and trough. Although the bureau notes that "most recessions are brief" and that "expansion is the normal state of the economy"[8], prolonged recessions are matters of historical record. One prominent example of an extended U.S. slowdown was the OPEC oil embargo recession of 1973-1975.

Two Quarters Of Decline

In a popular definition used by many investors and the press, a recession is determined by a negative economic growth rate for two or more consecutive quarters. This rule of thumb was first proposed in 1974 by the Commissioner of the U.S. Bureau of Labor Statistics, Julius Shiskin, in an article in the New York Times.[9]

The NBER admits that most recessions it identifies consist of two or more quarters of contracting GDP but are not necessarily limited to that definition. The bureau says that other factors, particularly the trajectory of gross domestic income, can take on equal importance in the determination. The NBER says it doesn't identify depressions but recessions within the cycles of peaks and troughs of economic activity. It notes only that the the term depression is "often used to refer to a particularly severe period of economic weakness."[10]

Recession Case Study: COVID-19 Pandemic

Perhaps the most notable global recession in history took place during the 2020 onset of the coronavirus (COVID-19) pandemic. Spurred by global lockdowns and travel bans, unprecedented uncertainty roiled financial markets from the U.K. to Japan.

On the brink of a financial crisis, emergency central bank monetary policies were instituted around the globe. Led by the United States Federal Reserve (Fed), central banks quickly cut short-term interest rates and promoted credit market liquidity. In the U.S., the Fed adopted a policy of "unlimited QE," which cut interest rates to near zero and injected hundreds of billions of USDs into the economy.

To complement dovish monetary policies, many countries launched coronavirus relief fiscal programs. For instance, in the United States, millions of Americans received stimulus payments directly from the U.S. Treasury. At the national level, independent bodies such as the International Monetary Fund (IMF) also extended COVID-19 financial aid.

Summary

A recession is the period of time between a peak in economic activity to a subsequent trough. During such times, two common economic indicators are a high unemployment rate and stagnant GDP growth.

One of the leading authorities on recessions is the National Bureau of Economic Research (NBER). Although NBER describes a normal economic slowdown as being short-term in nature, there have been long-term instances. When faced with the latter, both governmental and central bank authorities tailor policy to avert a full-blown financial crisis.

This article was last updated on 9th November 2021.

Russell Shor

Senior Market Specialist

Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.

References

1

Retrieved 20 Sep 2015 https://www.econlib.org/library/Smith/smWN.html

2

Retrieved 20 Sep 2015 https://journals.openedition.org/ress/110

3

Retrieved 20 Sep 2015 https://millercenter.org/the-presidency/presidential-speeches/november-14-1820-fourth-annual-message

4

Retrieved 20 Sep 2015 https://www.etymonline.com/word/recession

5

Retrieved 20 Sep 2015 http://www.mannkal.org/downloads/scholars/schumpeter-keynes.pdf

6

Retrieved 20 Sep 2015 https://www.frbsf.org/economic-research/files/el2010-05.pdf

7

Retrieved 20 Sep 2015 https://cepr.org/content/euro-area-business-cycle-dating-committee

8

Retrieved 20 Sep 2015 https://www.nber.org/news/business-cycle-dating-committee-announcement-january-7-2008

9

Retrieved 20 Sep 2015 https://www.cesifo-group.de/portal/page/portal/968433589AE90D9FE04400144FAFBA7C

10

Retrieved 20 Sep 2015 http://www2.nber.org/cycles/recessions_faq.html

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